seller agree to structure the transaction in this way. In a qualifying stock
purchase with at least 80 percent of the target’s stock obtained during a 12-
month period, the divesting parent and the acquirer can jointly make a
338(h)(10) election. The taxable gain or loss on the transaction is calculated
as the acquisition price less the divesting parent’s basis in the net assets of
the target. No tax is assessed on the difference between the purchase price
and the divesting parent’s book value basis in the stock.
The consultant team advised Fox that an asset transaction rather than a
stock transaction was preferred and a 338(h)(10) was not optimal. There
are two advantages to an asset sale. The first relates to the present value of
tax benefits that result from enhanced depreciation and amortization write-
offs. These emerge because the lower book value of purchased assets on the
seller’s balance sheet can now be stepped up to their fair market value on the
acquirer’s balance sheet, and depreciation and amortization schedules can
now be applied to these higher values. Second, by purchasing assets rather
than stock, the acquirer is not liable for past transgressions of the target’s
management that might emerge during the postacquisition period and that
due diligence could never be expected to identify, let alone value. An asset
sale severs the legal connection between the buyer and seller, whereas a
stock sale does not.
In contrast, a 338(h)(10) election preserves the former advantage of an
asset purchase, but not the latter. Generally, a 338(h)(10) election will be
demanded by the seller when the seller’s basis in stock exceeds its basis in
the net assets of the divested entity. This typically occurs when the divested
subsidiary was not developed organically but was developed and expanded
after it was acquired. In cases where the divesting parent internally gener-
ates a subsidiary, as was the case with HP, the seller is typically indifferent
about how the deal is structured.
The deal was finalized as an asset transaction. Frier paid $10 million for
HP’s subsidiary. Frier purchased both tangible and intangible assets. Pur-
chased tangible assets included equipment, material inventory, and receiv-
ables. Frier leased HP’s manufacturing plant. Intangibles included patents,
trade name, and HP’s customer list.
THE CONTROL VALUE
Richard Fox was very successful in integrating HP into Frier’s operations.
Frier’s cash flow grew at a rapid rate, and the hoped-for economies of scale in
the component business emerged when management aligned the production
needs of the industrial oven division with component production schedules. In
addition, cash flow from Frier’s industrial oven service business began to grow
rapidly, since Frier was now an OEM. Two years after the acquisition, Fox
The Restructuring of Frier Manufacturing 43